Disciplined Approach to Investing

Unemployment Rate Above 10%, Only Second Time Since WWII

2009-11-06T13:44:00.000-05:00

Today's Labor Department report that the unemployment rate rose to 10.2% is only the second time it has crossed the 10% threshold since the post World War II period. Today's unemployment rate represents a 26-year high for this indicator.

According to Chart of the Day, "it is also worth noting that the unemployment rate has tended to peak shortly after the end of the recession. Following the previous two recessions, however, the unemployment rate kept rising for many months following the beginning of an economic 'expansion.'"

Small Cap Relative Valuations Look Stretched

2009-11-05T23:59:00.000-05:00

Historically, small cap stock returns coming out of a bear market have outperformed large cap stocks. The performance of small caps relative to large caps since the March 9th lows has been no different. The small cap outperformance tends to run for a period of around two years.

(click to enlarge)

However, this might not be the case in this market cycle. The difference this time is the relative valuations of small caps look the most stretched going back to 1983. Given the valuation gap between small and large, it appears large caps might be the better asset class at this point in the cycle.

(click to enlarge)

One factor that may serve as a tailwind for large cap stock outperformance is the fact many large companies generate significant amounts of revenue from foreign sources. With the U.S. Dollar weakening, the conversion of foreign earnings into the dollar will provide a boost to earnings growth near term. Additionally, the developing market countries are experiencing better economic growth, thus a benefit to the large multinational companies.

Source:

The Market Recovery and Outlook for Small-Cap Stocks (PDF)
T.Rowe Price Report
By: Jack LaPorte
Fall 2009
http://individual.troweprice.com/staticFiles/Retail/Shared/PDFs/PriceReports/Fall2009PriceReport.pdf

Bullish Investor Sentiment In Freefall

2009-11-05T22:15:00.000-05:00

This week's bullish investor sentiment reported by the American Association of Individual Investors took a dramatic slide to the downside. The bullish sentiment reading fell 11.4 percentage points to 22.22% from last week's reading of 33.65%. This week's reading is the lowest since March 5th's bullishness reading of 18.92%. The bull bear spread widened to -33% compared to last weeks spread of -9%.

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When looking at the 8-period moving average of the sentiment at 37.94%, the decline is not so significant though. In the February-March 2008 time frame, the 8-period average was in the mid 20% range for six weeks. Nonetheless, investors seem to be doubtful of future market advances. As this is a contrary indicator, it is one factor that suggests the market could advance further over the next six months. Today's 200 point or 2% advance on the Dow Jones Index is a good start.

Dividend Aristocrats Performance Update

2009-11-04T19:44:00.000-05:00

It seems it has been some time since I updated the performance of Standard & Poor's Dividend Aristocrats. Year to date through November 4, 2009, the Aristocrats have generated a better return than the Dow Jones Industrial Index, 12.2% versus 11.7%, respectively. However, the Aristocrats performance has trailed the return on the S & P 500 Index's return of 15.9%.

In the below table, I have shaded the rows for those companies that have cut their dividend this year.

Full View

Dividend Payers Outperform Non Payers In October

2009-11-02T21:26:00.000-05:00

October was a down month for the S&P 500 Index seeing the index decline 1.87%. During the month, the dividend payers finally did outperform the non payers, -2.3% versus -6.2%, respectively. This is the first time payers have outperformed the non payers this year. On a year to date and 12-month time frame, the non payers continue to maintain a significantly higher return than the dividend payers.

Source: Standard & Poor's (xls)

Howard Silverblatt, Senior Index Analyst for Standard & Poor's notes in the October Monthly Market Attributes Report:

From March 9th, the 165 trading days produced a 53.16% gain for the S&P 500, which is the best gain since the 53.76% increase in October 1938.
While the market remains 33.80% off its 2007 high, the gains have mostly stayed with little profit taking and few major selling days.
Volatility picked up during October and continues to remain higher than historical values, although lower than the first half of 2009. Year-to-date, there have now been more days where the S&P 500 moved less than 1% than more than 1%. However, the swings have also been fewer and less drastic. The last 5% move was on March 23rd (+7.08%), with the last 3% move occurring on June 22nd (-3.06%).

If the easy money has been made with strong performance from the higher risk, lower quality stocks, the market may be entering a period where the higher quality dividend growers begin to outperform the non payers over an extended period of time.

Market Looks Oversold

2009-11-01T23:52:00.003-05:00

In looking at the percentage of S&P 500 Index stocks trading above their 50 day moving average, the market looks to be near a short term oversold position.

In looking at the 150 day moving average, 80% of S&P 500 stocks are trading above the 150 day M.A. This is down from 97% in September.

A Piotroski Low Price To Book Stock: Highway Holdings Ltd.

2009-11-01T11:44:00.000-05:00

One of the American Association of Individual Investors' better performing stock screens over the long run is the Piotroski Price to Book Screen.

Of late the number of companies passing the screen's criteria has been slim to none. The criteria of the screen are:

The price-to-book ratio ranks in the lowest 20% of the entire Stock Investor AAII database.
The stock does not trade on the over-the-counter exchange.

The return on assets for the last fiscal year (Y1) is positive.
Cash from operations for the last fiscal year (Y1) is positive.

The return on assets ratio for the last fiscal year (Y1) is greater than the return on assets ratio for the fiscal year two years ago (Y2).
Cash from operations for the last fiscal year (Y1) is greater than income after taxes for the last fiscal year (Y1).

The long-term debt to assets ratio for the last fiscal year (Y1) is less than the long-term debt to assets ratio for the fiscal year two years ago (Y2).
The current ratio for the last fiscal year (Y1) is greater than the current ratio for the fiscal year two years ago (Y2).

The average shares outstanding for the last fiscal year (Y1) is less than or equal to the average number of shares outstanding for the fiscal year two years ago (Y2).
The gross margin for the last fiscal year (Y1) is greater than the gross margin for the fiscal year two years ago (Y2)

The asset turnover for the last fiscal year (Y1) is greater than the asset turnover for the fiscal year two years ago (Y2).

Currently, only one company out of AAII's database of companies passes the screening criteria. The company is a Hong Kong based company, Highway Holdings Ltd. (HIHO) and trades on the NasdaqCM exchange.

Investors are highly encouraged to fully research any company mentioned before purchasing. In the case of HIHO, it is a small company trading at a stock price below $5 per share. The stock's market capitalization is $6.1 million. These below $5 stocks are typically very volatile investments.

James Grant Interview On WealthTrack: Believes Strong Recovery Ahead

2009-11-01T09:01:00.003-05:00

Consuelo Mack of WealthTrack interviews James Grant, Editor of Grant's Interest Rate Observer. By nature, James Grant is a glass is half empty type of person, yet he believes the economy will surprise to the upside and be surprisingly strong.

In the interview, Grant cites a quote from English economist, A.C. Pigou,

"The error of optimism dies in the crisis but in dying it ‘gives birth to an error of pessimism. This new error is born, not an infant, but a giant; for (the) boom has necessarily been a period of strong emotional excitement, and an excited man passes from one form of excitement to another more rapidly than he passes to quiescence.’"

One other noteworthy piece of advice to investors is that Wall Street is not an investors friend. Investors should buy investments not when they feel good, but when they feel the worst about a particular investment.

The interview is a worthwhile one that investors should view.

Stryker Increases Dividend 50%

2009-10-31T09:14:00.000-04:00

Yesterday Stryker Corp. (SYK) announced the company's dividend payment would be transitioned to a quarterly dividend from an annual one. In order to accommodate this change, SYK will pay a 10 cent fourth quarter dividend for 2009.

This will bring total 2009 dividends to 50 cents per share versus 33 cents per share paid in 2008. This represents a 51% increase in the dividend on a year over year basis.

Further, the company will begin paying a 15 cent per share quarterly dividend beginning in the first quarter of 2010. If the 2009 dividend is spread over four quarters (12.5 cents per quarter), the 2010 quarterly dividend will represent a 20% increase over the 2009 estimated quarterly dividend.

The payout ratio based on estimated 2009 earnings per share of $2.94 will be about 17%.

The company has an S&P Earnings & Dividend Quality Ranking of A+.

Bullish Sentiment At Lowest Level Since July 16th

2009-10-29T22:22:00.000-04:00

This week's release of bullish investor sentiment by the American Association of Individual Investors shows bullish sentiment fell to 33.65%. This is the lowest level for the bullishness reading since the bullishness reading was reported at 28.68% for the week of July 16, 2009. The eight period moving average fell slightly to 39.83% versus the prior week's average of 40.37%.

Individual investors do not appear to have reached the overly bullish state as of yet.

Supervalu Cuts Dividend

2009-10-26T20:14:00.001-04:00

Catching up after some travel.

Last week Dividend Aristocrat Supervalu (SVU) cut the company's dividend by 50%. SVU becomes the first consumer staples stock to reduce its dividend.

The new quarterly dividend is reduced to 8.75% from 17.5%.

The company's second quarter earnings came in at 35 cents per share versus 61 cents per share in the same quarter last year.

Full year earnings for February 2010 are estimated to come in at $1.94 and February 2011 earnings are projected at $2.01.

(click to enlarge)

Fund Flows During And After The Crisis

2009-10-25T18:48:00.002-04:00

Investors who stuck with equity investments (S&P 500 Index) in October 2008 and through the March 2009 sell off would now be up 9% from October 2008 through August 2009. Many investors liquidated equity investments in October and again in March.

Investors withdrew $70 billion from the stock market in October 2008 and another $50 billion in the February/March 2009 period.
As of October 16, 2009, one year after the peak in liquidations, investors who remained in the stock market had fared better than those who exited at the peak of the crisis and stayed on the sidelines.

One implication for investors as it relates to this data is the difficulty in trying to time the market. For investors, focusing on high quality dividend growth stocks provides the potential to minimize the downside volatility in the equity portion of ones portfolio.

Source:

Stay-the-Course Ahead of Panic Sellers
By: Fidelity's Market Analysis, Research, & Education Group
October 23, 2009
http://publications.fidelity.com/investorsWeekly/investorsWeekly/cms/IW0910crisis.dyn

Economic Activity Picking Up?

2009-10-23T18:09:00.001-04:00

As readers may have noticed from the limited number of posts to my blog this week, I was away from the computer due to some out of town travel. I traveled by car from Ohio to Florida on I-75. Along with my travel companion, we both commented on the number of semi trucks that were traveling the highway. The parking lots at a couple of truck stops we passed were packed full with semis. Even several of the rest areas were packed with semis. I am guessing all these trucks were not traveling with empty loads. At a minimum, I think the economy is experiencing some inventory restocking activity and possibly a pick up in consumer demand.

Tax and Spend

2009-10-23T17:53:00.000-04:00

As I have noted in several earlier posts, Congress is looking to place a tax on stock trades. They have not given up on this trading tax as noted by the below screen shot from my Site Meter account.

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Correlations Have Increased

2009-10-17T19:55:00.000-04:00

Investors are often advised to spread their investments across differing asset classes because of the lower correlation of these other asset classes. Unfortunately, the correlation of many of these other asset classes has continued to increase.

I have discussed this issue of higher correlation in earlier posts:

Diversification and Correlation During Market Crisis Periods

Global Equity Market Correlations Continue To Increase

Fidelity's Market Analysis, Research and Education (MARE) group recently updated correlation data as of August 31, 2009. As the below table notes, correlation versus the S&P 500 Index has increased across a number of asset classes except U.S. Government Bonds.

MARE notes the potential investment implications:

U.S. government bonds performed very well as riskier assets tumbled during the financial crisis in 2008, but so far in 2009 have fared poorly as riskier assets have rallied amid signs of economic stabilization and improvement.
There are potential scenarios where U.S. bonds could either hold up well in the months ahead (a double-dip recession, further financial system turmoil, etc.) or underperform riskier assets (rising inflation, increased concerns about the U.S. fiscal deficit/creditworthiness, or a better-than-expected economic recovery).
It remains to be seen whether the recent increase in correlations among riskier assets will define a new, more highly correlated era. In any case, investors are likely to be on safer ground anticipating that U.S. government bonds will continue to be one of the few ways to effectively diversify a portfolio.

In the end, investors need to be aware of this move towards higher correlation across a number of asset classes. Simply spreading ones investments into various asset classes will not necessarily ensure a higher risk adjusted return.

Source:

Where To Find Diversification In A Highly Correlated World (PDF)
Fidelity (MARE)
September 21, 2009
http://personal.fidelity.com/products/funds/content/pdf/where-to-find-diversification.pdf

Investors Sentiment Turns Bullish

2009-10-15T22:29:00.000-04:00

This week's sentiment survey by the American Association of Individual Investors saw bullish investor sentiment jump by 12.21 percentage points. The bull/bear spread was reported at +14 versus -6 last week. These weekly measures are volatile and looking at the 8-week moving average smooths out this variability. The 8 week average increased to 39.56% compared to 37.90% last week.

Data Source: American Association of Individual Investors

The bullishness reading is a contrarian indicator and a continued increase in individual investor bullishness would be one signal the market could be approaching at least a short term top.

Stock Market's Upside Potential

2009-10-15T00:24:00.001-04:00

When determining the future direction of the market, many investors and strategist turn to the price to earnings ratio. One key to using the P/E ratio is the calculation of earnings. Earnings are reported in several forms, one being "reported earnings" and the other referred to as "normalized" earnings. One significant point made in the article is the justification of using normalized earnings. Easterling notes,

"...if you only look at the P/E ratio reported for any quarter or year, the ratio during peaks and troughs will be quite distorted when compared to the more stable long-term average. About every five years or so, the reported P/E will reflect the opposite signal in contrast to a more rational view of P/E valuations. For example, the reported value for P/E in early 2003 reflected a fairly high value of 32 just as the S&P 500 Index had plunged to 800 (E had cycled to a trough of $25 per share). A P/E of 32 generally screams “sell” to most investment professionals; yet, in early 2003, that was a false signal! A more rational view using one of the business cycle-adjusted methods reflected a more modest 18. In a relatively low inflation and low interest rate environment, the scream should have been “Buy”…

Several years later, in 2006 (after an unusually-strong run in earnings growth), E peaked at $82 per share as the S&P 500 Index was hesitating at 1500. Most market pundits were recommending a strong “buy” due to a calculated P/E of only 17. Yet, using the rational business cycle-adjusted methodologies, the true message was “STOP”—P/Es were saying sell, with P/E more than 25.

Well the pundits were actually (sort of) right—P/Es did expand… Yet it was due to (what should have been expected) the normal down-cycle in E rather than the pundit-promoted increase in the stock market. So when investors’ stock market accounts were down almost 50%, they were handed explanations that the earnings decline was unexpected and the fault of the financial sector…

Many of the same pundits are bewildered by current market conditions and unsure about the future of E. The latest craze to extrapolate current conditions into the indefinite future has been named “The New Normal.” Slow economic growth, high saving rates, and unstable financial conditions—all fairly typical at the end of a recession—are now basic assumptions for years into the recovery expansion. Maybe this time will actually be different…or maybe not…

As for the market and P/E, it’s understandable that conservative investors and market spectators have watched the past six-month rally with awe. Yet the current P/E remains slightly undervalued and further gains are more likely; nonetheless, it is important to remain aware that typical market volatility makes it also likely that the market will experience significant short-term swings."

Ed Easterling of Crestmont Research provides an update on the market valuation in his quarterly P/E Report. The most recent report is detailed below and is a worthwhile reading. Beginning on page 4 of the report, he goes through his analysis of the potential target on the market (see Figure 6 on page 12.) Not that the market will go up in a straight line, but he does build a case for a 3-year target price on the S&P 500 Index of 1,685. The earnings figure utilized in the target is a normalized one that has been adjusted for inflation. A similar inflation adjusted valuation measure is used by Robert Shiller of Yale University.

The PE Report

The article's conclusion is the market remains in a secular bear market while still undervalued. As Crestmont has noted before, cyclical bull markets are common in longer term or secular bear market periods. Crestmont updates a table noting prior bear and bull market cylces.

For investors, inflation is a critical variable that will impact the value of the market. Staying abreast of inflation data points will provide some insight into the markets future direction. The advance from the market's March low has been impressive. Today's move above 10,000 on the Dow and 1,090 on the S&P 500 index was important from a technical point of view. Interestingly, the volume today was better than what we have seen of late, which is good, but the volume level is not what one would see at capitulation buying points. This is only "one" technical factor, but it would suggest the market could still move higher as some investors are in disbelief that the market has not had a significant correction that would consolidate the gains since March.

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Investor Sentiment Indicates Investors Are Cautious

2009-10-11T23:12:00.000-04:00

Over the past month, investor bullish sentiment has continued to trend lower as measured by the 8-period moving average of the bullish sentiment reading. Last week's bullishness reading of 35.09% feel below the long term average of 38.94% as reported by the American Association of Individual Investors. Additionally, last week's reading was nearly 8.5 percentage points lower than the bullishness reading in the prior week. The bull/bear spread was -6% versus +8% last week.

Source: American Association of Individual Investors

Market Performance After Big Down Years

2009-10-09T09:07:00.000-04:00

This has been a year that the old adages like "Sell in May and Go Away" or September is the worst month for market performance did not hold true. Some attribute this to the fact the market simply overshot on the downside in March.

In line with these adages, the market's performance in the year following big down years has generally been strong. Courtesy of Chart of the Day, the following chart notes the market's performance tends to be strong in those years following the years where the market declined significantly. As the chart notes, the exceptions were the early 1930's and 1978.

The below chart presents the performance of the Dow for the calendar year following the 15 worst calendar year performances of the Dow since 1896. The Dow's performance during the 2008 calendar year was the third worst on record. Could there be more upside to the market as we move into the end of this year?

(click to enlarge)

Source: Chart of the Day

RPM International Increases Dividend 2.5%

2009-10-08T21:41:00.000-04:00

For the 36th consecutive year, RPM International (RPM) announces a YOY increase in its quarterly dividend to 20.5 cents per share. This compares to a quarterly dividend of 20 cents per share in the same period last year: a 2.5% increase.

The estimated payout ratio is 65% based on May 2010 estimated earnings of $1.26. May 2011 earnings are estimated at $1.50. RPM earnings have been impacted by the economic slowdown resulting in payouts of 80%, 176% and 38% over the course of the last three years. RPM carries an Earnings and Dividend Quality Ranking of B.

(click to enlarge)

Hayman Advisors 3Q Newsletter

2009-10-05T23:46:00.001-04:00

J. Kyle Bass and his firm made billions shorting subprime mortgages prior to the mortgage meltdown. The below third quarter newsletter provides perspective on current monetary policy around the world. The newsletter contains an in depth discussion on China, Japan and the timing of potential inflation. The commentary is a must read for investors.

Hayman Advisors Third Quarter 2009 -

(H/T: Zero Hedge, Pragmatic Capitalist)

Tobin's q and The S&P 500 Scatter Chart

2009-10-01T19:15:00.001-04:00

I had a reader (H/T br) send me a scatter chart of Tobin's q and the S&P 500 Index. The data period is 1950-1999. I added a line estimating where the second quarter ratio would fall at .78.
tobins q & S&P 500

Another chart sent by the reader contains a scatter chart of the S&P 500 Index's future 10-year annualized return versus the inflation adjusted 10-year average P/E ratio. This data was obtained from Robert Shiller's data base (.xls file).
S&P 500 Return and PE Scatter Chart

Dividend Payer's Return Lags Non Payers

2009-10-01T18:08:00.000-04:00

As of the end of September, the return for the dividend payers in the S&P 500 Index continues to badly trail the return of the non payers. On a year to date basis, the payers' return equals 17.55% versus the non payers' return of 56.70%. The strongest performing stocks have been the lower quality ones and these tend to not pay dividends.

(click to enlarge)

Howard Silverblatt noted in a Dow Jones News Wire release:

In the third quarter, of about 7,000 U.S-traded companies, 191 increased their dividend for the period, down from 346 a year earlier and 439 in 2007. In contrast, 113 companies lowered their dividend payment during the quarter, down from 138 in 2008 but up from just 21 in 2007.

Howard Silverblatt said the third-quarter figures suggested that dividends may have finally hit a bottom. But he warned it may take several quarters of proven results for companies to be comfortable with increasing, or initiating dividends. Even then, Silverblatt said the level will likely be more subdued than what was seen two years ago.

According to Silverblatt, dividend increases have outnumbered cuts every year since 1955, with the average being 15 increases for every decrease. So far this year, the relationship is almost even, with increases at 707 and decreases at 730.

Tobin's "q" Still Below 1.0 In Second Quarter

2009-09-30T18:22:00.000-04:00

Argus Research performed a back-of-the-envelope value of Tobin’s ‘q’ – which is a measure of market valuation. This is based on the Federal Reserve's recently released quarterly Flow of Funds data for the second quarter of 2009.

"Investors will recall that 'q' is defined as the ratio of the market value of a firm to the replacement cost of its assets; in this case we are estimating those figures for the entire industry. According to Nobel Laureate James Tobin, the ratio of total stock market value to the stock market’s net worth (corporate net worth) is a reliable indicator of market valuation. When the stock market trades at a ‘discount’ to the replacement cost of its assets, the market is inexpensive, or cheaper to buy than build. This discount possesses 'q' ratios that are less than 1.0. Conversely, when 'q' exceeds 1.0, the market trades at a premium to its replacement cost. The run-up from 1996-2000 had 'q' approaching the unthinkable value of 2.0. The most recent (QII 2009) level of 0.78 is notably higher than the 0.65 posting in the first quarter, which was the lowest since QIV 1990."

(click to enlarge)

Source: Charles Schwab & Argus Research

Government Spending and Inflation

2009-09-29T23:01:00.000-04:00

The below chart speaks for itself when it comes to the relationship between government spending and inflation. It appears the inflation threat is not a matter of if, but when. Government spending is now 25% of GDP and higher interest rates will certainly have a negative impact on the government's future outlays as it likely pays a higher level of interest on the debt.

(click chart for larger image)

Source: Charles Schwab & Company and Ned Davis Research